There are many different types of water heaters on the market, each which have their own strengths and weaknesses.  Couple this with the presence of local and national rebates on energy savings and the decision to replace a water heater with a newer or different technology becomes a tad more difficult than just deciding on electric or gas. The newest "fad" (if we can call it that) is to install a tankless water heating system which provides on-demand hot water to either a whole house or a local tap or appliance. Analyzing the pros and cons of each technology will help you make the right decision.

Let's take a look at the different types of water heating systems. For the purpose of this article we'll stick with products intended to heat water in a residential home:

• Conventional Hot Water Heater (tank)
  This is a large insulated tank of water which can heat typically 40-50 gallons (but anywhere from 30-80+) either via electrical heating elements or natural gas or propane. These tanks include a thermostat which controls the temperature of water in the tank, and electric models can be coupled with an external timer to further save costs.
  Pros: Simple to replace, inexpensive compared to alternatives, good for warm or cold weather climates
  Cons: Inefficient compared to tankless (especially electric), prone to periodic failure, limited hot water supply
  
• Tankless (Demand or Instantaneous) Water Heater
  This type of water heater uses a heating element (heat exchanger) to heat the water instantly as it flows through the system. Unlike a tank-based system, the lack of standing water in a tank means that the heat isn't lost over time (standby loss) as the hot water sits waiting to be used. These systems are fairly new and claim to be more energy efficient since the water is only heated when needed (the system is "flow controlled" in that the heating only occurs when the hot water is activated and pulled through the system.) We don't recommend the electric type as much for retrofit as it involves running 60-80amps of service to the water heater location and is less efficient than gas models.
  Pros: Efficient, rebates available, never runs out of hot water
  Cons: Expensive, requires special installation
  
• Heat Pump Water Heater
  

  This is a lesser known type of water heating system that draws heat from the surrounding air to heat water in a tank. Because of the unique way in which it works, it is really only suitable for warmer climates and must be located in a larger space, like a utility room, garage or basement. They can be up to 3x more efficient than an electric water heater, and they cool and dehumidify the air in the room, making them desirable for warmer climates. A typical residential heat pump water heater can heat 15 gallons of water per hour by 80 degrees F, with a final storage temperature between 120 and 140 degrees F.
  Pros: Efficient, cools room during warm periods
  Cons: Expensive, not suitable for colder climates, requires larger space, limited hot water supply

• Solar Water Heaters
  Want to be energy efficient to the extreme? Why not use the sun to heat your water? Solar water heaters can work in various ways and be applied to heating a home's water, or just heat water for a swimming pool. Due to cloudy days and such, these systems rely on some kind of backup system (either tankless or conventional) to handle hot water production when the solar system is unable to deliver enough heat. An active solar heating system heats fluid by routing it through what's known as a "flat plate collector" which in turn returns to the storage tank and heats the water. A passive system actually stores the tank (as part of a "batch collector") on the roof or on the ground where it is heated directly by the sun.
  Pros: Makes you feel all warm and fuzzy for being green, low cost of operation
  Cons: Expensive, not as suitable for colder climates, requires complex installation, limited hot water supply

If your hot water heater breaks, typically you would just replace it with a gas or electric equivalent of the same type (usually conventional). With the recent government rebates, however, home owners who replace their hot water heaters in 2009 or 2010 can receive up to a $1500 rebate towards the cost of product and installation of a tankless water heater. The rebate works as follows:

• Purchase a qualifying tankless water heater. This tankless system must have an Energy Factor >= 0.82
  or a thermal efficiency of at least 90%. Currently all Energy Star compliant tankless water heaters qualify.
• Check to see if you have used any of this credit previously for replacement windows, insulation, roofs, etc - the tax credit is a maximum of $1500 for 2009-2010 purchases.
• Include the installation costs associated with the new tankless water heater and calculate your savings. 30% of the tankless water heater plus installation is eligible.

It's also important to check with your local gas and electric company for additional rebates. For example, my local gas provider will give me $450 if I replace my conventional gas water heater with a tankless system. With that being the case, my savings look something like this:

• $1200 (cost of tankless water heater) - $400 (30% tax credit) - $450 (energy conservation rebate) = $350

At that price it's almost ridiculous NOT to replace your hot water heater with a tankless system. Your ultimate decision will be up to you and the requirements of your home and water heating needs. Take a look at all of the options and take all of the potential tax savings into consideration before making a final decision.